Stocking for Shopping

- inventory control in theory and in practice: a review of current practices in the retail sector

by Alan Couper and Gill Mould

Development of Inventory Control during the 20th Century

There have been major developments in the theory and practice of inventory control during the 20th century. The developments have emerged from manufacturing industry but have been adopted by companies in other sectors, this has enabled them to reduce costs and improve their operating efficiency. This paper focuses on the retail sector and looks at how the developing theory of inventory control has been adapted to sever the needs of four major UK retailers.

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The driving force for the development of theory of inventory management has been manufacturing industry where inventory is seen as the buffer for supply and demand. Inventory of work in progress is also used to de-couple production processes. The benefits of the inventory control practices in this domain have percolated through to other sectors. This paper considers how these practices have been adapted to serve the needs of the retail sector. It reports the preliminary findings of a study that looked in detail at the inventory management procedures of major UK retailers.

A brief description of the major stock control systems developed during the twentieth century is given, (this can be omitted by readers familiar with the basics of inventory management). This is followed by four case studies describing the inventory practices found in major UK retailers today. These illustrate how the theory has been put into practice in this sector. This has resulted in a variety of hybrid of inventory management systems which serve the needs of the specific retailer concerned.

Development of Inventory Management Theory

During the 20th century there have been a number of milestones in the development of the theory of inventory management. In the early part of the century the economic order quantity (EOQ) was the main driver of inventory practices. A balance had to be struck between the costs of frequent re-ordering and expense of holding stock. Efficiency could be achieved by adhering to the EOQ principle. It provided the rational for centralised stock holding. In practice, it was incorporated into the re-order level or two-bin system of stock control. Where replenishment orders of the EOQ were placed whenever stock levels fell to a pre set re-order level. This level was set such that just enough stock was held to cover the lead time for delivery. One of the main problems with this system was that variable demand could lead to an erratic pattern of re-ordering, a nightmare for administration and for suppliers. The periodic review system came into being. This provided a regular reordering routine. The price paid was that re-order quantities were sub optimal. However, the total stock cost curve tends to be relatively flat around the EOQ and consequently relatively insensitive to moderate variations in order quantity. In practice the two systems were often combined to produce a hybrid of regular reviews with order quantities of around the EOQ. One of the benefits of these systems was that they were simple to operate and did not require sophisticated information systems.

In the 1960’s and 70’s Materials Requirement Planning (MRP) emerged, its adoption was accelerated by the corresponding development of computing power. In theory this is a very simple system which states that stocks should be ordered in the same proportions to their usage. So for example, a car manufacturer should hold five times as many wheels as he holds gear sticks. The system does not specify exactly how much to hold, but planning is usually performed on a routine basis, for example, stock will be ordered to meet the planned production for the next month. Forecasting is important with this system as in situations other than make-to-order, planning is based on the forecast of demand. Although essentially simple in theory, MRP becomes complex in practice when hundreds of items of stock are held and the same stock item is used in a variety of products. A computerised information system is essential. Through the 1970’s and early 80’s MRP quickly became the vogue in inventory management circles. It was only recently toppled from this position by the increasing use of Just-in–time (JIT) methods.

Although JIT is not a specific inventory control system the basic philosophy does have some implications for inventory management. In theory a JIT system should operate with zero inventory thus eliminating the problem altogether, in practice this is rarely achieved. The basic philosophy of JIT comprises of waste elimination, people involvement, total quality and supplier integration. Some of the techniques involved in implementing this philosophy, for example, make-to-order, small batch sizes and vertical integration have had an impact on inventory management procedures.

Inventory Management in the Retail Sector

Inventory management in the retail sector should be simpler than in manufacturing, as only one type of stock is held (goods for sale) as compared to up to three in manufacturing, (raw materials; work-in-progress and finished goods). The inventory management practices of four major UK retailers were examined in detail. The procedures adopted by the companies are described below.

Retailer 1: Furniture

The first retailer is a UK-wide specialist in the production and sale of quality bedroom and kitchen suites. The process of controlling stock is an area of high importance to the company because of its bulk and value. The company is currently in a transitional phase of reorganising its system of stock control with the aim of providing a more efficient system and improved customer service.

The inventory control technique currently used is to make items as and when they are ordered. The ordered furniture is delivered weekly to warehouses adjoining the stores. The aim is to keep stock to a minimum. The move to this system was initiated by Management’s awareness of the costs of holding stock. This system is able to operate because of the close ties between the retailer and manufacturer. The company plan to further develop the inventory system by replacing existing warehouses with large Home Distribution Centres (HDC) at central locations throughout the country. Customer deliveries will be made directly from the local HDC and call centres at each HDC will deal with customer complaints, service and distribution problems.

When implemented, supplier integration will become even more important than at present. Currently, suppliers must be aware that customer service depends on the weekly delivery of goods arriving on time and with the right quality, as there is no time to undertake quality control checks before the goods are dispatched to consumers. The removal of the warehouses makes this quality requirement even more important as the retail outlets will not have the space to store faulty returned goods. Supplier integration is not a major problem as the main suppliers are subsidiaries of the company and are therefore working towards similar goals. This has allowed a close relationship to develop and the existing trust and collaboration has resulted in continual improvements in quality and customer satisfaction.

This particular make-to-order approach takes its roots in the principles of JIT control systems, in particular waste elimination and supplier integration. The idea behind this is similar to the JIT concept in that it is the aim to remove from each store any aspects that do not add value to the service provided, therefore allowing the stores to concentrate on the most important function – selling the products.

Retailer 2: Clothing, homewear and food

Retailer 2 specialises in the sale of quality foodstuffs and a wide range of clothing and home wear. It is a highly successful retailer in terms of the profitability of its operations. A primary reason behind this success is the company’s recognition of the importance of an efficient inventory control system and the ruthless approach it has adopted to achieve this objective.

No stock is held in the retail outlet; all goods are on display. For clothing a range of colours and sizes is displayed. The number of items displayed will vary with the popularity of the product. Single items are held for goods with low demand but multiple items are displayed for more popular colours and common sizes. A similar policy operates for foodstuffs where stock level depends on the shelf space available. With perishable foods it is desirable to strike a balance between having sufficient stock to meet a peak day’s demand and avoiding wastage of items past their sell-by date. This ‘no stock’ policy is greatly facilitated the system of daily replenishment deliveries.

The company operates the ‘Automatic Stock Replenishment’ (ASR) system. The basic principle behind ASR is that a replenishment order is automatically placed with the local Distribution Center as soon as a sale has passed through the Electronic Point of Sale (EPOS) terminal at the retail outlet. The delivery of the replenishment product is scheduled to arrive the following day. The local Distribution Center is the only point in the entire distribution process holding stocks. This amounts to two weeks worth of stock for each store in the area, a level determined using forecasting techniques similar to those used in MRP. The forecast is based on the previous week’s sales but is flexible enough to allow seasonality and other exceptional circumstances to be built into the model. All staff are encouraged to play an active role in the system to ensure its efficiency. Tasks include a manual audit of stock to verify the accuracy of the computer system, reporting stock problems on the shop floor and carrying out random quality checks to ensure that products meet the retailer’s stringent requirements.

A possible problem of the ASR system is that replenishment orders include no provisions for safety stocks in the stores to cover surges in demand. The company feels, however, that the benefit of holding consignment stock at the local distribution center is more financially viable than the creation of waste at each store. Another problem of inventory systems using variable re-order quantities is that variations in demand can be greatly magnified further down the supply chain, the so-called ‘Forrester effect’. This is not a problem with this system as the local distribution center effectively provides a buffer for these daily variations in demand by holding two weeks stock.

These policies have taken ideas from three of the main inventory management techniques, this coupled with modern technology has lead the company to develop an innovative system of stock control. The continual review of stock is loosely based on the ideas of the traditional periodic review system in that stocks in the stores are replenished on a daily basis to a pre set level. The stock levels held at the distribution center are forecast in a way similar to that used in MRP. Lastly, the ‘people involvement’ ideas of JIT have been incorporated to ensure that every staff member is encouraged to play an active role in the system to ensure its efficiency. Thus the company has learned from inventory control developments in manufacturing industries. They have successfully integrated important features from three of the main theoretical techniques and coupled these with the capabilities of modern technology to become one of the leading retail companies in terms of inventory control.

Retailer 3: DIY

Retailer 3 is a UK-wide DIY store catering for both trade and retail customers. The inventory management system is based around the re-order level method of control in that stocks are continually monitored and updated. When a pre-determined level is reached, a replenishment order is automatically placed with the central depot where the majority of goods are stored as consignment stock. This system is replicated at the central depot where orders are then placed with suppliers. The delivery cycle is set in motion as soon as the order is received. As with retailer 2, a small amount of stock held at the central depot acts as a buffer and prevents the magnification of variations in demand down the supply chain. The fluctuating delivery pattern requires that retailer maintains excellent relations with its suppliers. This is further emphasised through the need for consistent quality. Quality control systems are in place at both the central depot and at every store to ensure goods are of the required quality.

The frequent delivery cycle enables storage facilities to be kept to a minimum at each store, although small storage areas do exist for goods with a high turnover rate. The uneven delivery cycle is not, however, faultless as it places a great deal of pressure on the company. A highly sophisticated computer system has been developed to alleviate some of these problems and staff involvement is encouraged at all levels through continuous training to minimise any difficulties.

The re-order system is sufficiently flexible to allow a certain degree of forecasting for times such as peak seasons and sale periods. The actual re-order level is continually updated and is based on previous demand in similar periods. Should the forecast be inaccurate, an inter-branch transfer system can provide goods at short notice.

The inventory control procedures used have evolved in a similar fashion to Retailer 2 in that it is a hybrid system based on traditional techniques. It combines features from three key inventory control techniques. The system is relatively simple and this encourages the involvement of the staff yet it is sufficiently flexible to meet consumer needs.

Retailer 4: Foods, clothing and audio

Retailer 4 is a national retailer requiring efficient inventory control procedures to maintain its position in this highly competitive sector of the market. As well as providing a wide range of foodstuffs it has diversified its product range in recent years, moving into audio and clothing markets to remain competitive. The various stock-types have led the use of three primary inventory systems: vendor-managed stock, forward planning and sales based ordering.

Vendor-managed inventory (VMI) is used within the clothing department. The clothing manufacturer controls the stock, which is pushed into retail outlets when required. The forward planning system (FPS) controls low turnover foodstuff stock. Loosely based on the periodic review technique, the following week’s demand is projected and an order placed weekly with the local distribution centre to replenish stock up to the capacity available. The sales based ordering technique is used to control high turnover stock where the need for daily deliveries requires the use of more sophisticated forecasting techniques, otherwise it is similar to the FPS. Based on the rate of sales as well as capacity, regression analysis is used to improve the forecasting accuracy. The systems are sufficiently flexible to be able to incorporate the seasonality and promotions on individual lines.

By improving the inventory controls, the retailer aims to reduce waste, the overall objective being to deliver goods directly onto the shelves. It is moving towards this goal by introducing daily deliveries, this in turn is placing increased pressure on its suppliers. The retailer has taken action to demonstrate its commitment to suppliers and more generally to improve the relationship between the two parties by reducing the number of suppliers. The net result of these refinements is that stock levels are lower and product availability is greater than ever before.

Summary of analysis

This brief examination of some of the UK’s largest retailers indicates that the ideologies and techniques of inventory management developed in manufacturing industries are being incorporated into the stock control systems of retail companies. A feature of the findings, however, is that none of the retailers surveyed have implemented any of these techniques in full. Instead, they have combined elements from the established techniques with modern-day technology to develop hybrid control systems compatible with their particular needs. This is illustrated in Figure 1.

From the analysis it is clear that each system has different features. Retailer 1’s make-to-order policy focuses on the JIT concepts of supplier integration and waste elimination. The latter is a common objective of each company. The underlying concept with retailer 3 is the re-order level approach and by combining this with basic forecasting methods and a strong emphasis on quality an extremely beneficial control system has evolved. Retailers 2 and 4 base their systems loosely on the periodic reviews with some refinements. Using frequent deliveries and forecasting models, with the incorporation of the modern techniques of automatic stock replenishment and vendor managed inventories respectively they have been able to develop state of the art.

None of the retailers work a JIT system, however, they do demonstrate the incorporation of some of the basic ideas from the JIT philosophy. For example, quality is emphasised strongly by each retailer. This seems reasonable, as it is fundamental if they want to remain ahead of the competition. Supplier integration is also important and also, with the exception of retailer 4, people involvement.

Conversely, MRP principles have been implemented to a lesser extent. The nature of Retailer 1’s business is suited to MRP as specifications may differ between customers, thereby requiring an updated Bill of Materials for each order. The need for working to plan or forecast as with MRP has been adopted by all the companies surveyed.

Hence we can see that each retailer has used features from the theoretical stock control systems but has tailored their system to meet their own particular needs. The resultant hybrid systems are efficient and flexible but suited to the particular operating environment of the retailer.